Economics 101

The Knowledge Problem Triple-Whammy

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One of the most profound insights of twentieth century economists was that of how knowledge is held in a society and what we do about it.  Nobel laureate, Friedrich August von Hayek, actually won the Nobel Prize, in part, for his discernment of the “knowledge problem.”

I’m sure you have heard the saying “you don’t know what you don’t know” which has never been one of my favorites because it’s rhetorical on its face.  But there is something profound there if we think about it.

How do we “know” anything in a world suffering from scarcity?  We know and understand God’s divine love and sacrifice for us through our faith and due to his grace.  But how do we know of the things of this world?  How do you know what route to take to get to work, what to cook for dinner, where to send your kids to soccer camp?  In a world of scarcity these decisions manifest themselves quite differently than they would in a world without scarcity.  We never have full and perfect information.  I mentioned this in my post about basic economic principles when I talked about hindsight being 20/20. Sometimes it is only after the fact that we learn what we need to previously know.

I remember when my husband and I bought our house and I had a new route to work that I had to figure out.  It was 38 miles away so every minute I could save mattered and added immensely to my sanity level! The first day I just plugged in the address to my GPS and went for it.  It was the longest way possible I could have taken.  It took me what seemed like forever to get there!

Eventually I had it figured out; if traffic was super heavy take route A, if not take route B.  If I had to be in especially early, take route C or D.  The point is that it took time and experience to build that storehouse of knowledge and once I had it built, I was able to be a more efficient commuter.  That information is what Hayek called “knowledge of the particular circumstances of time and place” (Individualism and Economic Order, pg. 80).

Hayek’s insight is that this knowledge is dispersed and scattered.  It is never known or revealed to one person.  Hayek stresses in his 1945 essay The Use of Knowledge in Society, that this as the central economic problem,

The particular character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.

What Hayek points out is a triple-whammy,

  1. Scarcity implies dispersed individual knowledge.
  2. The information we do have is often contradictory.
  3. And subjective valuation means we will all act upon the knowledge differently so behavior is more difficult to predict. It’s amazing that we get anything done at all!

Think about my commute.  I am sure there are some neighbors who had a similar commute and I could have attempted to figure out who they were and ask them their secrets for minimizing their time in the car, because even my GPS doesn’t possess the precise knowledge of time and place.  It doesn’t know where an accident will occur, where construction is active or if a marathon that day will have streets shut down.

All of this knowledge is dispersed and scattered and although some is easy to get (the marathon schedule), some is difficult to get (surveying all of my neighbors) and some we will never know (when an accident will occur before it happens).  The beauty is that markets help coordinate this disperse knowledge through voluntary exchange.

Hayek’s insights may seem simple. Okay so no one knows everything, big deal.  But there are big implications for how we live out a life of stewardship.  We must live in a society which allows for the most efficient transmission and dissemination of this dispersed knowledge.  IFWE’s Executive Director Hugh Whelchel has written about how we can use our gifts in this world to further God’s Kingdom.  Unleashing our creativity through our work depends on a market-based system which allows us to serve others and helps us gather and harness this dispersed knowledge for the common good.

Next we will talk more about the role of prices in helping to overcome dispersed knowledge.

Question: What knowledge do you use to make decisions in your daily life? Where do you get this knowledge? Leave a comment below.

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